A partnership is a formal agreement between two or more persons to manage and operate a business and share its profits and losses. The partners carry out duties on behalf of the firm. Partnerships aim to combine different resources and expertise to achieve common goals.
All partners are personally responsible and are jointly and severally liable for any business debts. The legal structure is also fuss-free and easy to manage. Despite the benefits, informal partnerships can run into some common problems.
Unlimited liability
The basic partnership as a structure is that all partners are jointly and severally liable for the acts and deeds done by other partners. A partnership does not have a separate legal identity and hence every partner is responsible for the debts of the firm. If the business has trouble staying afloat, a charge can be created on the personal assets of every partner to settle the liabilities of the firm.
Without a written formal agreement, one wrong decision can lead to the bankruptcy of all partners - a potential disaster waiting to happen. That is why it is essential to have a well-drafted partnership agreement.
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Equal profit-sharing
The lack of a written partnership agreement means that profits are shared equally amongst all partners, which is an unfair reward to a partner who does not contribute equally to the business compared to others who work hard.
An informal arrangement between partners leads to conflicts on how work, assets, and time are devoted to the business at hand. Unclear rules raise issues on how every partner contributes to the business and what assets and property he brings into the firm.
Division of work between partners
In a partnership agreement, the work-division is specified according to different levels of expertise, skills, and experience. An informal partnership agreement fails to define the specific roles and responsibilities to be carried on by every partner.
A crucial aspect in a partnership is to ensure that there is no stepping on toes, duplication of work, or assumption by third parties that all partners are liable for the work of the firm.
Conflicts can often arise in strategic planning, personal preferences, and ambitions which can be better managed with a well-drafted partnership agreement that focuses on procedures to be followed in case of disputes.
Transferring ownership
All partnerships begin with a common goal and purpose in mind - to combine and pool resources and expertise and start a business that will run successfully. This may not always happen. The future is uncertain, and a partnership can run into unforeseen problems.
Death, retirement, prolonged illness, insolvency, or unwillingness to continue are some scenarios in which a partner would want to move out of the arrangement and sell his stake in the firm.
The firm is unable to move in the right direction due to disagreements regarding the transfer of ownership due to the absence of a formal written arrangement in place.
Undefined authority
A proper authority structure in a partnership firm partnership deed defines the work to be done, roles, and responsibilities of every partner in the firm. There is no hierarchy in traditional partnership agreements, and every partner has equal authority and stake, which enables him to contribute to decision-making.
Informal arrangements, on the other hand, make it unclear to outsiders of the authority matrix. A partner could decide that is not in the firm’s best interest or which can jeopardize the other partners and make them liable to acts committed by him.